Risk assessment

Timid recovery after two years of recession

The economy’s adaptation to lower oil prices and the increase in gas exports to Turkey should favour a timid exit from recession in 2018. Household consumption (58% of GDP), down for three years, should start up again against a backdrop of rising incomes and falling inflation, as long as there are no further episodes of depreciation of the manat. While public investment in infrastructure and public building is expected to remain sluggish due to budgetary constraints, investments related to developing the Shah Deniz gas field in the Caspian Sea and the extension of the Trans-Anatolian Natural Gas Pipeline (TANAP) to the Greek/Turkish border, with the eventual goal of carrying gas from Azerbaijan to Europe, should accelerate in partnership with foreign partners. Private investment will continue to be affected by the high level of interest rates, intended to curb inflation and support the national currency, and the decline in credit associated with the weakness of the banking system. The contribution of foreign trade to growth should once again be slightly negative. The additional gas exports will only partially make up for the decrease in oil exports, which will still remain the main export (85%). Imports will grow more quickly due to increased consumption and investment. Apart from the hydrocarbon sector (43% of GDP), the rest of the economy should continue its 2017 momentum.

Balanced public and external accounts despite decreased oil revenues

In response to the decrease in budgetary revenues derived from hydrocarbons (50% of the total), the State has had to resort to the sovereign wealth fund and reduce its spending, particularly in investment, in order to limit the deterioration of the government balance. Given the unlikely rebound in oil revenues, it will be forced to rely on improved tax collection and a reduced non-oil deficit (27% of non-oil GDP) to regain room for manoeuvre. Despite this restrictive policy, the State has been unable to avoid increasing its debt burden. As a result of falling oil prices and the sharp depreciation of the manat, it has had to support public enterprises, particularly the country’s leading bank: the International Bank of Azerbaijan (IBA). The State has offloaded its non-performing assets (USD 5 billion) by entrusting them to a public entity created for this circumstance with its guarantee, before taking over its external debt (USD 2.45 billion after restructuring) on which it defaulted. Despite the surge in its indebtedness, the State continues to have a largely creditor position thanks to assets held by the SOFAZ sovereign wealth fund (USD 35 billion in June 2017, or 83% of GDP). Debt is likely to increase further, because the State wishes to develop the gas potential and the pipelines to ensure the relay of oil. In addition, IBA’s difficulties are not unique in the banking sector, which has seen the closure of numerous institutions and an increase in its non-performing assets: officially 13% in June 2017, but undoubtedly much more in reality. This weakness is accompanied by a decline in credit: banks, with 80% of their deposits in dollars, are only willing to lend in dollars in order to protect themselves against currency risk. Under such circumstances, borrowers prefer to resort to informal credit, even if the rates are usurious.

Despite the deficit in services and revenues, in return for the presence of foreign companies in the hydrocarbon sector, the current account balance was traditionally positive due to the impressive trade surplus generated by hydrocarbon sales. Volume erosion and falling prices have caused this surplus to vanish. In order to make sparing use of the reserves, which have fallen to the equivalent of four months of imports, the SOFAZ provides the central bank with sufficient funds to service the external debt of the company in charge of the TANAP and the State Oil Company of Azerbaijan Republic (SOCAR).

A well-established power

President Ilham Aliyev was re-elected for a third term in 2013. In 2017, he named his wife vice president. In the next election scheduled for 2018, he is expected to be re-elected, this time for a seven-year term thanks to the 2016 referendum. The Parliament, dominated by the president’s party, The New Azerbaijan Party (YAP), plays a secondary role with regard to the executive. Despite low growth and widening inequalities caused by decreased oil resources, social and political stability should continue. Political opposition is weak, and the authorities do not hesitate to use repression.

Despite some progress, the country’s governance (World Bank ranking) is still not as good as in the other two Caucasian States, but it is better than in most countries of Central Asia. A decline in freedoms can even be seen, which does not facilitate relations with the EU. However, despite shortcomings in handling insolvency and cross-border trade, the country ranks 65th out of 190 on the ease of doing business index.

Finally, the risk of a surged in the armed confrontation with Armenia regarding Nagorno-Karabakh and other occupied Azerbaijani territories by Armenia is limited by the strong joint influence exerted on the region by Russia, Turkey, and Iran. The situation in Nakhchivan, an Azerbaijani exclave between Armenia and Iran, is calm.